Xudong An

Asymmetric Information, Adverse Selection, and the Pricing of CMBS

We demonstrate that asymmetric information between sellers (loan originators) and purchasers (investors and securities issuers) of commercial mortgages gives rise to a standard lemons problem, whereby portfolio lenders use private information to liquidate lower quality loans in commercial mortgage-backed securities (CMBS) markets. Conduit lenders, who originate loans for direct sale into securitization markets, mitigate problems of asymmetric information and adverse selection in loan sales. Our theory provides an explanation for the pricing puzzle observed in CMBS markets, whereby conduit CMBS loans are priced higher than portfolio loans, despite widespread belief that conduit loans are originated at lower quality. Consistent with theoretical predictions of a lemons discount, our empirical analysis of 141 CMBS deals and 16,760 CMBS loans shows that, after controlling for observable determinants of loan pricing, conduit loans enjoyed a 34 basis points pricing advantage over portfolio loans in the CMBS market.

GSE Loan Purchases, the FHA, and Housing Outcomes in Targeted, Low-Income Neighborhoods

This study conducts two tests to evaluate the effects of the GSE mortgage purchase goals on on homeownership, housing outcomes, and credit access among communities that are the focus of the 1992 GSE Act and the HUD affordable housing goals. The first test exploits differences in the definition of lower-income and underserved neighborhoods under the 1992 GSE Act, which specifies loan purchase goals for the GSEs, and the 1977 Community Reinvestment Act, which governs loan origination activity among the federally-insured depository institutions. Once accounting for the endogeneity of GSE loan purchase activity, we find that (1) the GSEs appear to significantly increase their purchase intensity in neighborhoods targeted by the GSE affordable goals and (2) there are significant GSE-related effects on local housing outcomes. Increases in GSE purchase intensity are associated with declines in neighborhood vacancy rates and increases in median house values, both of which might be interpreted as neighborhood improvements. The second test focuses on any effects of the 1992 GSE affordable housing goals on the credit quality and performance of government-insured home mortgages. Our analysis derives from two hypotheses. Firstly, we test for elevated FHA prepayment speeds in GSE-targeted areas, owing perhaps to improved borrower access to conventional, conforming loans. Secondly, we evaluate any related deterioration in the credit quality and performance of the residual FHA-insured home mortgage pool. The results show significant deterioration in the average credit quality of FHAinsured borrowers post-1996. Further, Cox partial likelihood estimates of a proportional hazard model indicate elevated prepayment speeds among FHA-insured loans in GSE-targeted tracts. Both findings are consistent with the notion that FHA borrowers in targeted tracts had improved access to less expensive conventional, conforming loans, perhaps owing to enhanced outreach on the part of conventional lenders.

Omitted Mobility Characteristics and Property Market Dynamics:Application to Mortgage Termination

Property market dynamics depend on changes in long run equilibrium and on impediments to adjustment towards equilibrium. One of the most important aspects of property market dynamics is often attributed to the activities in the mortgage market. However, many impediment factors, such as changes in family status, education, neighborhood effects and job relocation, are often unobservable from micro household-level data. Since these omitted variables contribute to moving decisions and therefore to sale and default decisions, utility functions for sale and default are correlated through these unobservable variables; thus, the IIA assumption of the widely used Multinomial Logit Model (MNL) is violated. Under such circumstances, econometric theory suggests that the Nested Logit Model (NMNL) is a better choice, which obviates the limitation of MNL by allowing correlation in unobserved factors across alternatives. This paper empirically investigates the omitted household mobility characteristics problem in mortgage termination, and tests NMNL against MNL. Using loan level micro data, we find significant correlation between sale and default due to omitted borrower mobility characteristics. Our simulations find that NMNL out performs MNL in out-of-sample prediction.

Commercial Real Estate Rental Index: A Dynamic Panel Data Model Estimation

Using the actual quarterly rental income generated in the years between 2001 and 2010 by over 9,000 NCREIF commercial properties, we construct a commercial real estate rental index and estimate the time series properties (e.g., mean‐reversion speed and volatility) of market‐wide rental growth using a dynamic panel data model. The dynamic panel data model has several advantages over a standard hedonic regression. In addition, we incorporate age effects into our panel data model, and by doing so we correct the age bias in the repeated sales method and in the simple average method. Our estimates show that rental growth is cyclical but it generally lags behind broader economic growth. Surprisingly, the long‐term average rental growth is significantly lower than what is usually perceived, and the volatility of rental growth can be significantly under estimated when the conventional methods are adopted. We also find significant cross‐property type and cross‐region variations in the rental adjustment process. In contrast to the existing literature, we find a strong negative relation between rental growth and cap rate, and that this relation is significantly stronger than that between NOI growth and cap rate. Finally, we establish an empirical relation between price return and rental growth in the commercial real estate market.

What is Subordination About? Credit Risk and Subordination Levels in Commercial Mortgage-backed Securities (CMBS)

Subordination is designed to provide credit risk protection for senior CMBS tranches by allocating the initial credit losses to the more junior tranches. Subordination level should in theory reflect the underlying credit risk of the CMBS pool. In this paper, we test the hypothesis that subordination is purely about credit risk as intended. We find a very weak relation between subordination levels and both the ex post and ex ante measures of credit risk, rejecting our null-hypothesis. Alternatively, we find that subordination levels were driven by non-credit risk factors, including supply and demand factors, deal complexity, issuer incentive and a general time trend. We conclude that contrary to the traditional view, the subordination level is not just a function of credit risk. Instead it also reflects the market need of a certain deal structure and is influenced by the balance of power among issuers, CRAs and investors.

Default Risk of CMBS Loans: What Explains the Regional Variations?

We find substantial regional variations in CMBS loan default rates based on a 10-year history of nearly 38,000 CMBS loans. We seek to explain those variations with well documented risk factors such as negative equity, insolvency, property type, originator and state foreclosure law, as well as some newly introduced factors such as local unemployment rate, loan covenant (lock out) and natural disaster (Katrina). Many of the aforementioned factors are significant for CMBS loan default risk and they help explain part of the regional variations in CMBS loan default rate. We also find a significant negative relationship between local residential real estate appreciation and CMBS loan default – those regions with higher house price appreciation rates have lower default risk in CMBS loans. Moreover, differences in MSA-level residential real estate appreciation rate add explanatory power of the regional variations in CMBS loan risk, even though they do not fully explain the regional risk. Our findings have important implications for the CMBS investment community.

Default Option Exercise Over the Financial Crisis and Beyond

We document increased ruthlessness of mortgage default option exercise over the financial crisis and beyond. For a given level of negative equity, borrower propensity to default rose markedly over the 2007-2012 period and among hard-hit metropolitan areas. We show that elevated default option exercise was more salient to crisis-period defaults than were adverse shocks to home equity. Analysis of time-series and panel data indicates that proxies for the local business cycle, consumer sentiment, and federal foreclosure mitigation programs explain much of the rise in the negative equity beta. Difference-in-difference tests further corroborate unintended consequences of the Home Affordable Modification Program (HAMP) on borrower default option exercise.

Homeownership and Nontraditional and Subprime Mortgages

Abstract This article documents the growth and geographic distribution of nontraditional mortgages (NTMs) and subprime mortgages during 2000-2006, and examines the association between these products and homeownership at the county level between 2000 and 2012. It finds a significant relationship between the origination of NTM and subprime mortgages during the boom and changes in the number of homeowners (positive during the 2000-2006 period and negative during the 2006-2012 period) but no significant relationship with the change in the homeownership rate. Looking at specific categories of the population, the results indicate a positive relationship between the presence of NTMs and subprime mortgages and increased numbers of homeowners for young households as well as for low income and minority households, but the relationship is smaller than for the general population. Overall, the relationship between NTMs and homeownership is stronger than the relationship between subprime mortgages and homeownership during the boom and it is less negative during the bust.

Financial Literacy and Mortgage Credit: Evidence from the Recent Mortgage Market Crisis

We use a novel approach to calculate individual “financial literacy score” for a large set of California mortgage borrowers and then investigate the relation between financial literacy and mortgage outcomes. We find borrowers with low financial literacy are more likely to accept riskier mortgages and have mortgages with disadvantageous characteristics, ceteris paribus. In addition, they pay a higher rate, are less likely to take advantage of advantageous prepayment opportunities, and are more likely to default. Our estimates show that financial literacy is economically significant where mortgage outcomes are concerned. Our lower-bound estimate is that converting low literacy borrowers into high literacy borrowers would lead to

Credit Expansion, Competition, and House Prices

460 million in reduced mortgage payments annually in California due to reduced borrowing cost. Other reasonable scenarios yield savings exceeding